What does China’s central bank digital currency show about the future of private crypto assets and about the potential disintermediation of traditional financial services?
Any UK citizen or business can choose to be a payment anarchist. People can ignore the fiat currency and request payments for goods or services in whatever form they like: cowrie shells, cabbages or Bitcoin.
What they can’t do is require that monetary debts be paid in cowrie shells, cabbages or Bitcoin. If creditors don’t accept legal tender, they can’t sue for non-payment.
That might not sound momentous, but it is a big anchor for the value of a fiat currency. Legal tender is also a liability of the central bank. Commercial banks create most of the money people use, but trust in the state stands behind it. The existence of legal tender is what makes money, money. That is: a store of value, a unit of account and the medium of exchange.
By that definition, private crypto assets can’t be money, despite - and much to the horror of the International Monetary Fund (IMF) - El Salvador’s decision to make bitcoin legal tender. Bitcoin is backed only by speculation and by the argument (or hope) that currencies can do without financial intermediaries and state oversight. But wild swings in the valuation of fashionable assets are nothing new, of course.
“I’m inclined to put cryptocurrencies in the same bracket as tulips,” says Charles Taylor, a Visiting Scholar at GW Law School and a former deputy comptroller of the currency in the US. “[That is] with the exception of central bank digital currencies.”
The only major economy that has already launched a CBDC is China, which unveiled trials of the e-CNY at the end of 2021. But others aren’t far behind. A 2021 survey by The Bank for International Settlements found that 86% of central banks were “actively researching the potential” of CBDCs.
What China is doing
The e-CNY aims to be retail “digital cash” and it is fully backed by the People’s Bank of China (PBoC). Choosing to replace cash and not bank accounts is an important step. It ensures that commercial banks won’t be disintermediated, and it spares the PBoC a major headache: offering consumer accounts and deciding who gets to borrow what.
China has decided that interest can only be paid on bank deposits, not on the e-CNY itself. Banks are also the only institutions that can convert e-CNY into deposits and pay it out again as cash.
But why has China launched the digital yuan while other major economies are still carrying out consultations and trials?
“To cater to its population’s needs as people use cash less and less,” says Dr Sara Hsu, associate professor of supply chain management at the University of Tennessee, Knoxville, and the author of China’s Fintech Explosion.
Hsu points out that because of the widespread use of Alipay and WeChatPay, which link people’s bank accounts to a digital wallet, China is already close to being cashless and many places no longer accept notes and coins.
“In addition, China has been opposed to decentralised digital currencies, such as Bitcoin [which was banned last year], and this is its answer to crypto,” she adds.
China is not the only jurisdiction that has an uneasy relationship with cryptocurrencies. Facebook’s Diem digital currency project was stopped short partly because of US regulatory objections.
Huge private platforms where the majority of people live their economic lives – as many as one billion Chinese people do so on Alipay – are, arguably, a threat to monetary stability if the transactions use a private crypto asset.
Big Tech cut down to size
There is likely another factor in China’s move to a CBDC: data. Before the crackdown, around 10% of China’s consumer loans were made through Alipay’s app. The state-owned banks complained Alipay had an unfair advantage thanks to lower costs of capital and lighter regulations.
But the big platforms also had another advantage. Because they had largely relegated commercial banks to funding pipes, they had vast amounts of data that the state-controlled banks did not.
In 2021, Chinese regulators required Alipay to spin off its lending businesses, Hubaei, which offers consumer credit and Jiebei, which provides small unsecured loans. With them went the data they gathered.
The China chief economist at Deutsche Bank, Yi Xiong, said in a research note that the design of the e-CNY gives China’s big banks “an entry point… to break into a business… currently dominated by big tech firms,” and that this will substantially change the payments sector in China.
Having a digital yuan that puts the commercial banks front and centre in payments, and opens up the sector to new competitors, is certainly a step away from private Big Tech. But it’s arguably also a step closer to “Big State”.
CBDCs and privacy concerns
“Cash is wonderfully anonymous and incredibly convenient,” Taylor says. “That anonymity might be a disadvantage in an autocracy and a reason for a country like China to introduce a CBDC.”
China has said that the e-CNY will offer “controllable anonymity”, but what does that mean in practice? “The authorities can see which digital wallet the digital yuan is in and digital wallets are tied to individuals,” says Hsu.
Authorities will be able to trace transactions and carry out compliance checks including anti-money laundering and know your customer. The user can choose to be anonymous to counterparties, which some have argued will be a disadvantage for online platforms.
CBDCs in international payments
One of the often-cited advantages of CBDCs is that they could remove friction from the notoriously sclerotic international payments market. However, Taylor is not sure that is the case.
“Many of the suggested advantages of a CBDC in terms of international payments may be illusory,” he says. He points out that a lot of rents are taken out on the course of an international payment and that the system involves navigating different time zones, legal histories and institutional histories.
“If I send money from the US to India, it has to go from a US bank to a bank in India. I’m not sure a CBDC really gets round the institutional issues,” Taylor adds.
Challenging the dollar’s reserve currency status has also been mooted as a reason for the e-CNY. China is the world’s biggest producer of rare earth metals, which are increasingly in demand for rechargeable batteries and electronics, among other things. Could China move to “de-dollarise” the trade in rare earths? “It is possible,” says Hsu, “but, the digital yuan is like cash so that would likely take second place to normal account transfers.”
Hsu says it’s also not clear how the digital yuan could be tracked cross-border or whether it will be able to collect the identification information of overseas citizens.
Taylor, too, is sceptical that the e-CNY will increase the footprint of the yuan in
international trade. “The international dollar payments system is very efficient,” says Taylor. “The network effects in these things are so strong that the conventions of using the dollar, or SWIFT, are very hard to overturn.”
Do central banks need CBDCs?
“I think that generally cryptocurrencies might make sense where there is great distrust of government institutions,” says Taylor. “Central banks in the OECD are generally trusted.”
He also doubts that central banks will find their hands forced by the increased use of cryptocurrencies.
“There are already lots of transactions beyond the direct reach of the central bank, but as long as some component is controlled and the relationship between that and the rest is predictable and doesn’t change rapidly, there isn’t really a problem,” he says.